The Economics Of The Canadian Oil Sands Are A Mess

Protesting oil sands crude has become a Hollywood cottage industry with celebrities like Daryl Hannah, Robert Redford and Julia Louis-Dreyfus lining up for the cause.

But there are much larger forces at work that is making a mess of the economics of Canada's vast bitumen fields.

This week the price oil sands producers receive fell to $48 a barrel below the international benchmark after a $4.50 or 21% widening to $25.00 of the spread between Canada's heavy oil and US crude.

The deepening discount for Western Canada Select (WCS) - a blend of heavy oil sands crude and conventional oil - comes on top of declines for US benchmark Nymex West Texas Intermediate (WTI).

US crude is now close to $23 cheaper than global oil in the form of North Sea Brent. WTI always traded at a premium, but that changed in 2009 when the Saudis stopped using it as the benchmark and switched to Brent.

Brent is trading $107 in Europe which translates to an effective price for bitumen-derived oil from Alberta's oil sands of under $60 a barrel.

The value of Syncrude - a light oil made from oil sands after undergoing an expensive upgrading process - also plunged this week to just 75c above WTI from a $15.00 premium in September.

The lack of pricing power for Canada's oil sands players is often blamed on the fact that 99% of exports end up in the US.

Producers cannot access new markets in Asia as pipeline projects to the west coast languish in a regulatory morass.

There is no clear timeline for TransCanada's (NYSE:TRP) Keystone XL to finally cross the border into Canada.

That Enbridge's (TSX:ENB) Northern Gateway pipelines is built at all is an ever diminishing prospect and even Kinder Morgan's (NYSE:KMI) proposal to expand its existing pipeline to the Pacific coast, is facing fierce opposition.

There exists also the absurd situation that the populous centers in the eastern part of Canada have to import 60% of their needs and pay global prices.

There is talk of converting an existing gas pipeline to carry Alberta oil to the east, but at this point that's all it is; talk.

And even if these projects do come off the ground Alberta producers like Suncor (TSX:SU NYSE:SU), Cenovus (TSX:CVE NYSE: CVE) and Imperial Oil (TSX:IMO NYSE:IMO) would still find it hard to compete.

Bitumen is expensive to extract, upgrade and refine and cannot compete with the many new shale oil plays which have pushed US production to its highest level in a decade.

Unlike oilsands oil, Bakken attracts a premium to WTI and the region is also competing for pipeline and refinery contracts with Alberta.

Apart from the boom in US production and a strong loonie - as the Canadian dollar is referred to by locals - Alberta's oil sands players are also threatened by escalating labor and equipment costs.

A recent report by research house Wood Mackenzie shows break-even costs for building new steam-driven projects is in the $65 - $70 a barrel range.

Mining developments - the truck and shovel method accounts for a fifth of all projects - need at least $90 - $100 oil.

If those numbers make for dire reading in Calgary boardrooms - and in Bejing which is pouring money into the industry - consider that today's prices are actually an improvement.

Existing projects in Alberta can still make money at $45 a barrel, but in June oilsands crude was trading at a discount of $26.50 when Nymex WTI was below $80. Syncrude in February fell to $23 below WTI.

Canada loves to brag that when including the oil sands, its oil reserves are second only to Saudi Arabia's.

But if these are the kind of numbers you're working with that's all it's going to stay - reserves in the ground.